“This month’s increase in nonresidential construction spending is far more consistent with the anecdotal information floating around the industry.”—ABC Chief Economist Anirban Basu.

Nonresidential construction spending bounced back in October, expanding 1 percent on a monthly basis and 4.3 percent year over year, according to a Dec. 2 release from the U.S. Census Bureau. Spending for the month totaled $611.8 billion on a seasonally adjusted, annualized basis. Additionally, the government revised the September spending figure up to $605.8 billion from $596.1 billion.

“This month’s increase in nonresidential construction spending is far more consistent with the anecdotal information floating around the industry, which generally indicates that firms are becoming busier and that backlog is expanding,” said Associated Builders and Contractors (ABC) Chief Economist Anirban Basu. “Although last month’s numbers for nonresidential construction spending and employment were disappointing and could have implied the nation’s nonresidential construction recovery is stalling, that is not the case.

“The outlook for 2015 remains upbeat,” said Basu. “The economy has gained momentum over the past six to seven months and that is consistent with more aggressive construction starts and spending during the year to come. Even as the economy has gained momentum, the Federal Reserve has remained extraordinarily accommodative due in part to benign inflation readings. Low interest rates combined with solid economic momentum likely mean expansion for the nonresidential construction industry during the year ahead.”

Nonresidential construction spending slipped in August, according to an Oct. 1 release from the U.S. Census Bureau. Nonresidential construction spending shrank 1.2 percent on a monthly basis in August, but has still managed to expand 6 percent on a year-over-year basis. Spending for the month totaled $603.7 billion on a seasonally adjusted, annualized basis. The government also revised the July spending figure down from $617.8 billion to $611.3 billion.

“This is why it is never a good idea to get excited about one month of data,” said Associated Builders and Contractors Chief Economist Anirban Basu. “After a significant acceleration in spending in July, August’s report depicts a steady but unspectacular recovery. Based on various industry surveys, including ABC’s own confidence and backlog indicators, the steady pace of recovery will continue.

“Macroeconomic fundamentals remain promising for growth moving forward,” said Basu. “Job growth has been reasonably steady during the past 12 months and the quality of jobs added to the economy has improved during the course of the current year, which helps explain the ongoing recovery in office-related spending. Federal Reserve policy remains accommodative and interest rates remain benign, which will help support business investment, including in construction, going forward. Consumer spending also should help prompt additional construction, including in the lodging and amusement/recreation categories.”

Seven of 16 nonresidential construction subsectors posted increases in spending in August on a monthly basis.

Office-related construction spending grew 1.1 percent in August and is up 18.9 percent from the same time one year ago.

Manufacturing-related spending grew 1.7 percent on a monthly basis and is up 14.5 percent on an annual basis.

Lodging construction spending is up 0.9 percent on a monthly basis and is up 10.2 percent on a year-over-year basis.

Amusement and recreation-related construction spending grew 0.9 percent on a monthly basis and is up 3 percent from the same time last year.

Communication construction spending expanded 3.4 percent for the month, but is down 10.5 percent on a year-over-year basis.

Religious spending grew 0.9 percent for the month and is up 1.4 percent from the same time last year.

Sewage and waste disposal-related construction spending gained 0.8 percent for the month and has grown 3.5 percent on a 12-month basis.

The nominal value of construction spending put-in-place fell 0.8 percent in August with downward revisions to data in the previous two months. Private residential and nonresidential both posted declines.

Overall Construction Spending Weaker than Expected

Construction spending fell 0.8 percent in August to a $961.0 billion annual pace. Declines were broad based, with total residential spending down 0.1 percent and nonresidential falling 1.2 percent. Public construction outlays fell 0.9 percent in August, which was mostly due to weakness in state and local highway, street and education spending.

Although the report was weaker than expected, construction spending is well known for its wide monthly swings. That said, the overall trend still points to gradual upward momentum. Overall spending on a three-month annualized basis is up at a 0.9 percent rate, with nonresidential increasing at a 6.1 percent pace. On the other hand, residential is down 7.2 percent on a three-month annualized basis.

Private residential construction spending fell a modest 0.1 percent, with home improvement pulling the headline lower. Home improvement has declined in seven of the last eight months and is down 10.3 percent over the past year. The string of negative readings in this component suggests the pickup in home remodeling is winding down. Spending on home improvement likely peaked in December 2013 and is now down 18 percent from that high in August. Although housing market indicators remain mixed, single-family spending eked out a modest 0.7 percent increase, its second monthly gain. Multifamily construction outlays also rose in August, increasing 1.4 percent. Apartment demand remains strong, as young adults still prefer to rent rather than own, especially in gateway cities.

Private nonresidential construction spending fell 1.4 percent in August, and is now up 9.2 percent from a year earlier. Despite the decline, manufacturing, communication and lodging made the largest contributions to the headline, while power fell on the month. Manufacturing outlays have shown solid gains in recent months and are up almost 15 percent over the past year. Much of the improvement in this component is due to the shale gas boom as chemical companies that use natural gas as an energy source or as feedstock take advantage of record-low natural gas prices. Chemical manufacturing is up a whopping 57.2 percent from a year earlier and rose 3.3 percent in August. Excluding chemical manufacturing, manufacturing spending fell 0.1 percent during the month.

Looking Ahead: Nonresidential Spending Still on Track

Overall construction spending has improved at a sluggish pace but should gain traction along with better economic growth. Leading nonresidential indicators, including starts, architectural billings and the Dodge Momentum Index, suggest conditions are improving. In the months ahead, we should see increased spending from the $957 million Nordstrom Tower located in midtown Manhattan. Outlays for the second tallest building in the country will show up in residential, retail, and hotel.

Construction spending rose 0.2 percent in April, which was lower than the consensus estimate. Private residential and public spending rose, while private nonresidential fell for the fourth straight month.

Residential Outlays Continue to Improve

· Total construction spending rose 0.2 percent in April to a $953.5 billion annual pace with upward revisions to previous months’ data. Private residential construction spending rose just 0.1 percent on the month, with home improvements holding down the headline. However, private nonresidential outlays fell 0.1 percent on the month. The decline was concentrated in communication, power and manufacturing.

Public Spending Expected to Slow in Coming Months

· Public construction spending rose 0.8 percent in April, but could begin to falter in the coming months. The largest component of public outlays, ‘highway & street,’ is up 4.9 percent on a year-ago basis, but the expected slower pace of reimbursements this summer to states from the federal Highway Trust Fund (receives revenue from a federal fuel tax and distributes to states for infrastructure projects) could weigh down total public outlays.

As the economy gradually recovers, nonresidential construction spending remains unchanged—a good sign the downturn in the industry has stopped, according to the Construction Backlog Indicator (CBI) produced by Associated Builders and Contractors (ABC). CBI also remained nearly unchanged between the second and third quarters of 2013.

“The most recent CBI reading suggests much of the growth next year is likely to occur after the first quarter of 2014, and only if a successful resolution to lingering federal budgetary issues emboldens decision-makers,” said ABC Chief Economist Anirban Basu. “Even with successful negotiations in Washington, D.C., ABC expects publicly financed segments to continue to be hamstrung by reluctant state and local government budget officials.”

Despite the fact the nation is in its fifth year of recovery, nonresidential construction spending remains roughly 20 percent below the cyclical and all-time peak achieved in October 2008. While the most recent CBI is 2.8 percent higher compared to a year ago, it suggests the long-awaited rapid acceleration in nonresidential construction spending will not occur in the very near term.

“For the past year, businesses and consumers grappled with higher tax rates, rising interest rates, a federal shutdown, and the uncertainties associated with health care reform, sequestration and debt default. In October, the International Monetary Fund downgraded the 2013 U.S. growth forecast from 1.7 percent to 1.6 percent,” Basu said “As if headwinds emerging from the federal government were not enough, the uncertain resolution of Detroit’s bankruptcy has induced more cautious behavior among certain large and similarly situated American cities, which continues to impact the outlook for U.S. infrastructure investment, “Basu said.

However, there is optimism in today’s CBI release. “Even slow growth leads to construction opportunities,” Basu said. “Ongoing recovery steadily produces lower vacancy rates, higher rents and more comfortable lenders. However, growth also results in higher interest rates and ABC believes this factor will begin to serve as a more meaningful speed governor in late 2014 or in 2015.”

On a quarterly basis, backlog declined in three out of four regions, with the largest quarterly decline occurring in the Northeast.

The South was the only region to experience expanding backlog during the third quarter, with the lengthiest backlog of any region at 9.8 months. States such as Louisiana, Georgia and Florida are experiencing significant improvement in construction industry conditions.

Backlog has expanded in the Northeast and South over the past year, but declined in both the West and Middle States. This is likely due to softening industrial activity in certain Middle States over the past year and softening infrastructure investment in the West.

Analysis

“Construction momentum has become increasingly divergent within regions,” Basu said. “For example, the Middle States continue to be associated with the shortest average backlog at 6.15 months; however, construction activity has been robust in North Dakota, Iowa, Wisconsin and Minnesota.

“The South and the West are likely to experience the most expansion in backlog going forward due to economic momentum in California, Washington, Idaho, Arizona and Nevada, more stable housing markets in Georgia and Florida and continued expansion of energy production in Oklahoma, Louisiana and Texas,” Basu said.

Backlog expanded only for the commercial/institutional segment in the third quarter, which was driven by a combination of increasing work from the nation’s health care system and from rising consumer outlays.

Infrastructure saw backlog decline for a third consecutive quarter, primarily due to still-wounded state and local government budgets along with erratic decision making in Washington, D.C.

Average backlog declined in the heavy industrial category, in part due to a weak global economy that has frustrated exporters. Manufacturing capacity utilization stands at just 76.1 percent, which is too low to permit aggressive industrial facility buildout.

Analysis

“CBI continues to reflect the U.S. recovery’s dependence on consumer credit and spending,” Basu said. “This translates into construction projects in several categories, including shopping centers, lodging, distribution and fulfillment centers.

“On the other hand, states and local governments continue to remain defensive in terms of capital budgeting, in part because of uncertainty regarding the level of future support from the federal government and pressures related to underfunded pensions and retiree health care costs,” Basu said.

Average backlog declined for the largest firms (annual revenues in excess of $100 million), which is consistent with a lack of momentum in large-scale infrastructure projects.

The smallest firms have experienced backlog expansion for the past two quarters due to spending growth in nonresidential construction and the recovery’s expansion to encompass a greater share of firms. Backlog now stands at 7.31 months, the highest level since the second quarter of 2011 when the stimulus package was creating opportunities for many subcontractors.

Over the past year, backlog has expanded for all firm size categories with the exception of the $30-$50 million category, a group that often comes into direct competition with larger firms and is also associated with more fragile banking and insurance relationships than their larger counterparts.

“Today’s nonresidential construction industry competition favors large contractors due to their resources to comply with a growing number of regulations, a capacity to enter green construction segments, a level of flexibility that permits entry into rapidly expanding geographic markets, and an ability to attract both youthful and veteran construction industry talent in an environment characterized by emerging skills shortages,” Basu said. “These firms not only have the capacity to take on the largest projects, but also have the ability to embrace the most productive (and expensive) technologies. However, there does not seem to be enough large projects to permit significant average backlog expansion even in the large firm size category.”